Question

Now that you understand what GDP is and how it is calculated do you think it is a good measure of economic activity. Make sure you reference any problems you may have with Real versus Nominal GDP.

Just for your information a very big discussion is currently underway concerning Real versus Nominal GDP as a target of economic policy. If any takes intermediate Macroeconomics we will spend time examining that issue.

Answer 1

Gross Domestic Product (GDP) measures total income of everyone in the economy.

GDP also measures total expenditure on the economy’s output of Goods and Services.

GDP is actually the ⁽¹⁾market value of all ^(2),(3)final goods & services ⁽⁴⁾produced ⁽⁵⁾within a country
in a ⁽⁶⁾given period of time.

(1) Goods are valued at their market prices, so:

•GDP measures all goods using the same units (e.g., dollars in the U.S.), rather than “adding apples to oranges.”

•Things that don’t have a market value are excluded, e.g., housework you do for yourself.

(2) Final goods are intended for the end user.

Intermediate goods are used as components or ingredients in the production of other goods.

GDP only includes final goods, as they already embody the value of the intermediate goods used in their production.

(3) Goods & Services:

GDP includes tangible goods (like DVDs, mountain bikes, beer)

and intangible services (dry cleaning, concerts, cell phone service).

(4) GDP includes currently produced goods, not goods produced in the past.

(5) GDP measures the value of production that occurs within a country’s borders, whether done by its own citizens or by foreigners located there.

(6) Period of Time: usually a year or a quarter (3 months).

Y = C + I + G + NX

• GDP(Y)
• Consumption (C)
• Investment (I)
• Government Purchases (G)
• Net Exports (NX)

GDP does not include:

the quality of the environment, leisure time, non-market activity, such as the child care a parent provides his or her child at home, an equitable distribution of income

But why GDP is important ?

• Having a large GDP enables a country to afford better schools, a cleaner environment, health care, etc.
• Many indicators of the quality of life are positively correlated with GDP. For example…

1. As GDP of a country increases the life expectancy of country increases [ (Life Expectancy)/GDP: US,Japan > China > India > Pakistan ]
2. As GDP increases adult literacy als increases: Same examples of nations
3. As GDP increases internet usage also increases accordingly: Same examples of nations

It clearly indicates that some trends can be explained very well using GDP and thus it is an important measure of economic growth though not very perfect.

Real vs Nominal GDP:

Inflation can distort economic variables like GDP, so we have two versions of GDP:
One is corrected for inflation, the other is not.

• Nominal GDP values output using current prices. It is not corrected for inflation.
• Real GDP values output using the prices of a base year. Real GDP is corrected for inflation.